US and Canadian markets were flat but intra-month there was a lot of movement and with different sectors there continues to be changes of leadership.

This speaks to two things. One is the benefit of holding a diversified portfolio. Second is the benefit of using a cash flow based asset allocation.

The cash flow based asset allocation that I deploy with all my clients ensures that we have 3-7 years of cash flow in bonds and fixed income investments – that is the foundation of the portfolio… more below.

In this newsletter I will cover:

The cash flow based asset allocation allows us a time frame to recover from a worst case market correction and it is unlikely that a market correction would take longer than 7 years.

If you have 7 years of cash flow held outside of the stock market then it really doesn’t matter how much is in stocks as a percentage of the portfolio.

This is how a pension fund would look at things. They plan for their known cash flows and invest the rest in growth assets.

This is a cash flow based asset allocation.

Markets have largely been driven by news as there is some soft data but also some bright spots too.

Market Overview

My take is that there are two things going on. One that is short term and one that is long term.

Short term, Canada seems to be holding up economically with good private business hiring, core inflation right where the Bank of Canada likes it and no signs of major problems.

In the US, unemployment is still low and retail sales are holding up. Inflation is around 2% which is where the central bank wants it.

This is the positive for both economies.

In Canada retail sales were a little weak whereas in the US the causes for concern are in industrial production and manufacturing. These sectors in the US have held up prior to this and is causing concern.

Coupled with the US president not showing an end to the trade wars with China and around the world the US is selling off. Will Canada benefit in some way?

The US dollar is still strong but that could change relative to the Canadian dollar if the Bank of Canada refuses to be more accommodative with interest rates. In turn, a stronger Canadian dollar, will cause our exports to be less competitive and therefore less economic activity.

Short term, Canada seems to be a better bet as we are slightly more insulated from the President’s tweets however I feel that is more surface oriented.

As the US is Canada’s largest trading partner should the US go through a contraction then Canada will certainly experience economic pain too.

Longer term, the fundamentals of the Canadian consumer seem stretched in my view. The US consumer has much more room to take on debt which increases economic activity.

The Canadian consumer has little room to increase borrowing as is caught between a rock and a hard place.

If the Canadian economy does very well then Canada should increase interest rates which will negatively affect a highly leveraged consumer.

If the Canadian economy does poorly, then Canadians will suffer on the income front and will be negatively affected with the amount of leverage in the system.

If interest rates stay close to where they are now, and economic activity holds up, then Canadians will likely stay status quo for a while.

That is a Goldilocks scenario though and nothing stays the same forever. There is a perennial ebb and flow to all things.

The US on the other hand has more room to issue credit to the consumer and could arrange a quick resolution of trade wars if needed although that may be politically flawed.

Therefore on the longer term the US has more to gain from a trade war resolution and can cope with an economic slowdown better than Canada can.

My thesis remains to stay invested in the US primarily even though it may underperform in the short term. In the long run I don’t know when Canada will reconcilliate its consumer debt but it will need to happen and I won’t be told in advance. Therefore I’m preparing for this eventuality even if it takes a couple of years. I’m playing the long game.

Elsewhere, China’s retail sales were softer and vehicle sales were also a bit soft.

In Germany inflation was soft at 1.1%, they printed a negative quarterly GDP growth for the second time this year and will likely require more monetary accommodation.

As the European hegemon, Germany still remains my favourite place for international exposure when I look for it.

 

Case Study on Investments, Debt and Retirement

Details:

  • Couple in their mid-30’s
  • Earn more than $200,000 household income
  • Have RRSP, LIRA and a rental property

The question that was posed to me was: Is there something better out there than what I’m currently in?

The answer was yes on several points:

  1. Investments could be more specific rather than a target date fund which is a “set it and forget it” strategy
  2. Optimize debt to increase tax deductibility
  3. Lower investment costs
  4. Stop buying funds with deferred sales charges and front end fees
  5. Set semi-annual financial targets to push the family forward

The discussion centered around applying an investment strategy that considered both the long term and short term imbalances in the markets. As discussed above my investment thesis is to be more focused on the US and to use a cash flow based allocation strategy.

The rental property was mortgaged to about 50% of the value of the house. As interest paid on your primary residence is not currently tax deductible, my recommendation was to increase the loan to value on the rental to as high as 80% and use those proceeds to invest. Check with a tax professional prior to doing this.

They can also use a debt acceleration strategy whereby they use their line of credit on their home to pay down their fixed mortgage and deposit all savings and paychecks into the line of credit and use it like a chequing account. There are a couple of lenders out there who do this so contact me if you want more information.

Lowering investment costs was another area for improvement. The MER (annual cost) on the funds they had was between 2.2% and 2.4% whereby my fees were lower and would save about $1,000 per year.

If they sell one of their funds then they would be subject to a deferred sales charge and my recommendation was not buy these funds any more as they are punitive for up to 7 years if they decide to make a change.

There were also a purchase of front end fees where the advisor would have charged between 1-5% on the intial purchase. If the fee was 5% then for every $100 they invested, they would have only invested $95. They would have required a 5.26% return just to get back to their initial investment.

Lastly, set semi-annual financial targets. I recommended that they get a will and power of attorney in place. It is something that they should have in place as they have children and assets. By setting it as a 6 month target, my process is to break it down in to four manageable steps and set deadlines on each of them to make sure that they’re moving forward.

By working together they will get one step further to financial security and build a solid financial household every six months.

 

Podcasts!!!

I’ve just published my 50th podcast! It’s been a journey and I’m not comfortable going on video or recording audio. I much prefer the written word as my form of communication and by consistently putting out video and audio I have done 50 episodes this year so far.

I have also gotten much better and am having fun doing them. They are a great way for me to communicate smaller pieces of financial concepts and applications in 5-30 minute segments.

Recent podcasts include:

It’s been a busy month and I look forward to helping more people achieve their optimal financial wealth.

Until next time,

Trevor Dale, CFA

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